Disclosures September 30, 2016
Table of Contents Introduction 1 Background 1 Overview 1 Disclosure Matrix 3 Components of Capital 10 Capital Adequacy 10 Standardized Risk-Weighted Assets 11 Capital Ratios 11 Capital Buffer 11 Credit Risk 11 Securitizations 12 Equities not Subject to the Market Risk Capital Rule 13 Subsequent Event 13
INTRODUCTION The Charles Schwab Corporation (CSC) is a savings and loan holding company, headquartered in San Francisco, California. CSC was incorporated in 1986 and engages, through its subsidiaries (collectively referred to as the Company), in wealth management, securities brokerage, banking, money management, custody, and financial advisory services. At September 30, 2016, the Company had $2.73 trillion in client assets, 10.0 million active brokerage accounts, 1.6 million corporate retirement plan participants, and 1.1 million banking accounts. Significant business subsidiaries of CSC include the following: Charles Schwab & Co., Inc. (Schwab), which was incorporated in 1971, is a securities broker-dealer with over 330 domestic branch offices in 46 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, England, and serves clients in Hong Kong through one of CSC s subsidiaries; Charles Schwab Bank (Schwab Bank), which commenced operations in 2003, is a federal savings bank located in Reno, Nevada; and Charles Schwab Investment Management, Inc., which is the investment advisor for Schwab s proprietary mutual funds, referred to as the Schwab Funds, and Schwab s exchange-traded funds (ETFs), referred to as the Schwab ETFs. The Company provides financial services to individuals and institutional clients through two segments Investor Services and Advisor Services. The Investor Services segment provides retail brokerage and banking services, retirement plan services, and other corporate brokerage services. The Advisor Services segment provides custodial, trading, and support services as well as retirement business services. The basis of consolidation that CSC uses for regulatory reporting is consistent with the basis used for reporting under generally accepted accounting principles in the U.S. (U.S. GAAP) as established by the Financial Accounting Standards Board. BACKGROUND In July 2013, the U.S. Federal banking agencies finalized a rule to implement strengthened regulatory capital requirements for U.S. banking organizations consistent with Basel III (Final Regulatory Capital Rules). The Final Regulatory Capital Rules, among other things, subjected savings and loan holding companies to consolidated capital requirements, established Common Equity Tier 1 (CET1) Capital as a new capital standard, increased minimum required risk-based capital ratios, narrowed the eligibility criteria for regulatory capital instruments, provided for new regulatory capital deductions and adjustments, and modified methods for calculating risk-weighted assets (the denominator of risk-based capital ratios). The Final Regulatory Capital Rules provided for a one-time election, which CSC and Schwab Bank made, to exclude accumulated other comprehensive income from the calculation of CET1 Capital. The Final Regulatory Capital Rules also introduced a capital conservation buffer effective January 1, 2016, which will increase annually until fully implemented on January 1, 2019. See Capital Buffer on page 11 for more details. OVERVIEW This document, and certain of CSC s public filings, present the regulatory capital disclosures in compliance with Basel III as set forth in 12 C.F.R. 217.63 - Disclosures by Board-regulated institutions (the Rule). CSC s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 () and its Quarterly Report on for the quarterly period ended September 30, 2016 () filed with the Securities and Exchange Commission (SEC) contain management s discussion of the overall corporate risk profile of CSC and related management strategies. These Disclosures should be read in conjunction with the, the, the Consolidated Financial Statements for Bank Holding Companies dated September 30, 2016 (), and the Consolidated Reports of Condition and Income for a Bank with Domestic Offices Only for the quarter ended September 30, 2016 (FFIEC 041). CSC s Disclosure Matrix (see page 3) specifies where the disclosures required by the Rule are located. 1
Following are links to the referenced public filings: Filing Link to Filing http://www.sec.gov/archives/edgar/data/316709/000031670916000067/schw- 20151231x10k.htm September 30, 2016 https://www.sec.gov/archives/edgar/data/316709/000031670916000101/schw- 20160930x10q.htm Consolidated Financial Statements for https://www.ffiec.gov/nicpubweb/nicdatacache/fry9c/fry9c_1026632_201 Bank Holding Companies - 60930.PDF dated September 30, 2016 Consolidated Reports of Condition and Income for a Bank with Domestic Offices Only FFIEC 041 for the quarter ended September 30, 2016 https://cdr.ffiec.gov/public/managefacsimiles.aspx Note search terms below: Report = Call\TFR Report Date = 9/30/16 Institution Name = Charles Schwab Bank The Rule applies only to the consolidated Company, with the exception that capital ratios for each depository subsidiary must be disclosed. 2
DISCLOSURE MATRIX Table Disclosure Requirement Disclosure Location Scope of Application (Table 1) The name of the top corporate entity in the group to which subpart D of this part applies. A brief description of the differences in the basis for consolidating entities for accounting and regulatory purposes, with a description of those entities: (1) That are fully consolidated; (2) That are deconsolidated and deducted from total capital; (3) For which the total capital requirement is deducted; and (4) That are neither consolidated nor deducted (for example, where the investment in the entity is assigned a risk weight in accordance with this subpart). Any restrictions, or other major impediments, on transfer of funds or total capital within the group. The aggregate amount of surplus capital of insurance (d) subsidiaries included in the total capital of the consolidated group. The aggregate amount by which actual total capital is less than the minimum total capital requirement in all (e) subsidiaries, with total capital requirements and the name(s) of the subsidiaries with such deficiencies. Capital Structure (Table 2) Summary information on the terms and conditions of the main features of all regulatory capital instruments. Disclosure Page Introduction Pg. 1 Introduction Pg. 1 Capital Adequacy MD&A Capital Management Note 14 Regulatory Requirements Not applicable. The Company does not have any insurance subsidiaries. Not applicable. The Company does not have any subsidiaries with total capital requirements where total capital is less than the minimum requirement. Note 11 Stockholders Equity Pg. 10 Source Reference if applicable Pg. 22-24 Pg. 54-55 Pg. 51-52 Quantitative: The amount of common equity tier 1 capital, with separate disclosure of: (1) Common stock and related surplus; (2) Retained earnings; (3) Common equity minority interest; (4) Accumulated other comprehensive income (AOCI); and (5) Regulatory adjustments and deductions made to common equity tier 1 capital. The amount of tier 1 capital, with separate disclosure of: (1) Additional tier 1 capital elements, including additional tier 1 capital instruments and tier 1 minority interest not included in common equity tier 1 capital; and (2) Regulatory adjustments and deductions made to tier 1 capital. The amount of total capital, with separate disclosure of: (1) Tier 2 capital elements, including tier 2 capital instruments and total capital minority interest not included in tier 1 capital; and (2) Regulatory adjustments and deductions made to total capital. Pg. 46-47 Pg. 46-47 (d) Pg. 46-47 3
Table Disclosure Requirement Disclosure Location Capital Adequacy (Table 3) Quantitative: (d) A summary discussion of the Board-regulated institution s approach to assessing the adequacy of its capital to support current and future activities. Risk-weighted assets for: (1) Exposures to sovereign entities; (2) Exposures to certain supranational entities and MDBs; (3) Exposures to depository institutions, foreign banks, and credit unions; (4) Exposures to PSEs; (5) Corporate exposures; (6) Residential mortgage exposures; (7) Statutory multifamily mortgages and pre-sold construction loans; (8) HVCRE loans; (9) Past due loans; (10) Other assets; (11) Cleared transactions; (12) Default fund contributions; (13) Unsettled transactions; (14) Securitization exposures; and (15) Equity exposures. Standardized market risk-weighted assets as calculated under subpart F of this part. Common equity tier 1, tier 1 and total risk-based capital ratios: (1) For the top consolidated group; and (2) For each depository institution subsidiary. Disclosure Page Capital Adequacy Pg. 10 MD&A Capital Management Capital Adequacy Pg. 10 Not applicable. CSC is not subject to the Market Risk Capital Rule. Capital Adequacy FFIEC 041 Schedule RC-R Part I Regulatory Capital (e) Total standardized risk-weighted assets. Capital Adequacy Capital Conservation Buffer (Table 4) At least quarterly, the Board-regulated institution must calculate and publicly disclose the capital conservation buffer as described under 217.11. At least quarterly, the Board-regulated institution must calculate and publicly disclose the eligible retained income of the Board-regulated institution, as described under 217.11. At least quarterly, the Board-regulated institution must calculate and publicly disclose any limitations it has on distributions and discretionary bonus payments resulting from the capital conservation buffer framework described under 217.11, including the maximum payout amount for the quarter. Capital Buffer Capital Buffer Capital Buffer Pg. 10 Pg. 10 Pg. 11 Pg. 11 Pg. 11 Source Reference if applicable Pg. 22-24 Pg. 48 FFIEC 041 Pg. 65 Pg. 49-58 Pg. 48 Pg. 48 Pg. 48 4
Table Disclosure Requirement Disclosure Location Credit Risk: General Disclosures (Table 5) Quantitative: The general qualitative disclosure requirement with respect to credit risk (excluding counterparty credit risk disclosed in accordance with Table 6), including the: (1) Policy for determining past due or delinquency status; (2) Policy for placing loans on nonaccrual; (3) Policy for returning loans to accrual status; (4) Definition of and policy for identifying impaired loans (for financial accounting purposes); (5) Description of the methodology that the Boardregulated institution uses to estimate its allowance for loan and lease losses, including statistical methods used where applicable; (6) Policy for charging-off uncollectible amounts; and (7) Discussion of the Board-regulated institution s credit risk management policy. Total credit risk exposures and average credit risk exposures, after accounting offsets in accordance with GAAP, without taking into account the effects of credit risk mitigation techniques (for example, collateral and netting not permitted under GAAP), over the period categorized by major types of credit exposure. For example, Board-regulated institutions could use categories similar to that used for financial statement purposes. Such categories might include, for instance (1) Loans, off-balance sheet commitments, and other non-derivative off-balance sheet exposures; (2) Debt securities; and (3) OTC derivatives. Geographic distribution of exposures, categorized in significant areas by major types of credit exposure. MD&A Critical Accounting Estimates Note 2 Summary of Significant Accounting Policies Note 3 Receivables from Brokerage Clients MD&A Risk Management Note 16 Financial Instruments Subject to Off-Balance Sheet Credit Risk or Concentration Risk MD&A Risk Management Note 9 Offsetting Assets and Liabilities Credit Risk Disclosure Page Pg. 11-12 Source Reference if applicable Pg. 50-51 Pg. 60-68 Pg. 68 Pg. 17-20 Pg. 82-84 Pg. 17-20 Pg. 45-46 MD&A Risk Management Credit Risk MD&A Risk Management Pg. 17-20 (d) Industry or counterparty type distribution of exposures, categorized by major types of credit exposure Pg. 11-12 Pg. 17-20 (e) By major industry or counterparty type: (1) Amount of impaired loans for which there was a related allowance under GAAP; (2) Amount of impaired loans for which there was no related allowance under GAAP; (3) Amount of loans past due 90 days and on nonaccrual; (4) Amount of loans past due 90 days and still accruing; (5) The balance in the allowance for loan and lease losses at the end of each period, disaggregated on the basis of the Board-regulated institution s impairment method. To disaggregate the information required on the basis of impairment methodology, an entity shall separately disclose the amounts based on the requirements in GAAP; and (6) Charge-offs during the period. Amount of impaired loans and, if available, the amount of past due loans categorized by significant geographic areas including, if practical, the amounts of allowances related to each geographical area, further categorized as required by GAAP. (f) Schedule HC-N Past Due and Nonaccrual Loans, Leases, and Other Assets Pg. 38-39 5
Table Disclosure Requirement Disclosure Location Credit Risk: General Disclosures (Table 5) continued Reconciliation of changes in ALLL. (g) Schedule HI-B Charge-Offs and Recoveries on Loans and Leases and Changes in Allowance for Loan and Lease Losses Disclosure Page Source Reference if applicable Pg. 8 (h) Remaining contractual maturity delineation (for example, one year or less) of the whole portfolio, categorized by credit exposure. General Disclosure for Counterparty Credit Risk-Related Exposures (Table 6) Quantitative: The general qualitative disclosure requirement with respect to OTC derivatives, eligible margin loans, and repo-style transactions, including a discussion of: (1) The methodology used to assign credit limits for counterparty credit exposures; (2) Policies for securing collateral, valuing and managing collateral, and establishing credit reserves; (3) The primary types of collateral taken; and (4) The impact of the amount of collateral the Boardregulated institution would have to provide given a deterioration in the Board-regulated institution s own creditworthiness. Gross positive fair value of contracts, collateral held (including type, for example, cash, government securities), and net unsecured credit exposure. Note 16 Financial Instruments Subject to Off-Balance Sheet Credit Risk or Concentration Risk MD&A Risk Management Note 9 Offsetting Assets and Liabilities (4) Not applicable. CSC does not have any contingent payment obligations that would result from a ratings downgrade. Note 16 Financial Instruments Subject to Off-Balance Sheet Credit Risk or Concentration Risk Pg. 82-84 Pg. 17-20 Pg. 45-46 Pg. 82-84 Note 9 Offsetting Assets and Liabilities Pg. 45-46 A Board-regulated institution must disclose the notional value of credit derivative hedges purchased for counterparty credit risk protection and the distribution of current credit exposure by exposure type. Notional amount of purchased and sold credit derivatives, segregated between use for the Board-regulated institution s own credit portfolio and in its intermediation activities, including the distribution of the credit derivative products used, categorized further by protection bought and sold within each product group. Credit Risk Mitigation (Table 7) The general qualitative disclosure requirement with respect to credit risk mitigation, including: (1) Policies and processes for collateral valuation and management; (2) A description of the main types of collateral taken by the Board-regulated institution; (3) The main types of guarantors/credit derivative counterparties and their creditworthiness; and (4) Information about (market or credit) risk concentrations with respect to credit risk mitigation. Not applicable. CSC does not hold credit derivatives. Not applicable. The Company does not transact in credit derivatives. MD&A Critical Accounting Estimates Note 2 Summary of Significant Accounting Policies Note 16 Financial Instruments Subject to Off-Balance Sheet Credit Risk or Risk Concentration MD&A Risk Management Note 3 Securities Available for Sale and Securities Held to Maturity Note 9 Offsetting Assets and Liabilities Note 10 Fair Values of Assets and Liabilities Pg. 50-51 Pg.60-68 Pg. 82-84 Pg. 17-20 Pg. 35-37 Pg. 45-46 Pg. 46-51 6
Table Disclosure Requirement Disclosure Location Credit Risk Mitigation (Table 7) continued Quantitative: For each separately disclosed credit risk portfolio, the total exposure that is covered by eligible financial collateral, and after the application of haircuts. For each separately disclosed portfolio, the total exposure that is covered by guarantees/credit derivatives and the risk-weighted asset amount associated with that exposure. Securitization (Table 8) The general qualitative disclosure requirement with respect to a securitization (including synthetic securitizations), including a discussion of: (1) The Board-regulated institution s objectives for securitizing assets, including the extent to which these activities transfer credit risk of the underlying exposures away from Board-regulated institution to other entities and including the type of risks assumed and retained with resecuritization activity; (2) The nature of the risks (e.g. liquidity risk) inherent in the securitized assets; (3) The roles played by the Board-regulated institution in the securitization process and an indication of the extent of the Board-regulated institution s involvement in each of them; (4) The processes in place to monitor changes in the credit and market risk of securitization exposures including how those processes differ for resecuritization exposures; (5) The Board-regulated institution s policy for mitigating the credit risk retained through securitization and resecuritization exposures; and (6) The risk-based capital approaches that the Boardregulated institution follows for its securitization exposures including the type of securitization exposure to which each approach applies. A list of: (1) The type of securitization SPEs that the Boardregulated institution, as sponsor, uses to securitize third-party exposures. The Board-regulated institution must indicate whether it has exposure to these SPEs, either on- or off-balance sheet; and (2) Affiliated entities: (i) That the Board-regulated institution manages or advises; and (ii) That invest either in the securitization exposures that the Board-regulated institution has securitized or in securitization SPEs that the Board-regulated institution sponsors. Summary of the Board-regulated institution s accounting policies for securitization activities, including: (1) Whether the transactions are treated as sales or financings; (2) Recognition of gain-on-sale; (3) Methods and key assumptions applied in valuing retained or purchased interests; (4) Changes in methods and key assumptions from the previous period for valuing retained interests and impact of the changes; (5) Treatment of synthetic securitizations; (6) How exposures intended to be securitized are valued and whether they are recorded under subpart D of this part; and (7) Policies for recognizing liabilities on the balance sheet for arrangements that could require the Boardregulated institution to provide financial support for securitized assets. Note 16 Financial Instruments Subject to Off-Balance Sheet Credit Risk or Concentration Risk Note 9 Offsetting Assets and Liabilities Not applicable. CSC does not hold credit derivatives. Not applicable. CSC does not securitize assets. Not applicable. CSC does not securitize assets. Not applicable. CSC does not securitize assets. 7 Disclosure Page Source Reference if applicable Pg. 82-84 Pg. 45-46
Table Disclosure Requirement Disclosure Location Securitization (Table 8) continued (d) An explanation of significant changes to any quantitative Not applicable. CSC does not securitize assets. information since the last reporting period. Quantitative: The total outstanding exposures securitized by the Boardregulated Not applicable. CSC does not securitize assets. (e) institution in securitizations that meet the operational criteria provided in 217.41 (categorized into traditional and synthetic securitizations), by exposure type, separately for securitizations of third-party exposures for which the bank acts only as sponsor. For exposures securitized by Board-regulated institution Not applicable. CSC does not securitize assets. in securitizations that meet the operational criteria in 217.41: (f) (1) Amount of securitized assets that are impaired/past due categorized by exposure type; and (2) Losses recognized by Board-regulated institution during the current period categorized by exposure type. (g) The total amount of outstanding exposures intended to be Not applicable. CSC does not securitize assets. securitized categorized by exposure type. Aggregate amount of: (1) On-balance sheet securitization exposures retained (h) or purchased categorized by exposure type; and (2) Off-balance sheet securitization exposures categorized by exposure type. (1) Aggregate amount of securitization exposures retained or purchased and the associated capital requirements for these exposures, categorized between securitization and resecuritization exposures, further categorized into a meaningful number of risk weight bands and by risk-based (i) capital approach (e.g., SSFA); and (2) Exposures that have been deducted entirely from tier 1 capital, CEIOs deducted from total capital (as described in 217.42(1), and other exposures deducted from total capital should be disclosed separately by exposure type. Summary of current year s securitization activity, including the amount of exposures securitized (by (j) exposure type), and recognized gain or loss on sale by exposure type. Aggregate amount of resecuritization exposures retained or purchased categorized according to: (1) Exposures to which credit risk mitigation is applied (k) and those not applied; and (2) Exposures to guarantors categorized according to guarantor creditworthiness categories or guarantor name. Equities Not Subject to Subpart F of This Part (Table 9) Quantitative: The general qualitative disclosure requirement with respect to equity risk for equities not subject to subpart F of this part, including: (1) Differentiation between holdings on which capital gains are expected and those taken under other objectives including for relationship and strategic reasons; and (2) Discussion of important policies covering the valuation of and accounting for equity holdings not subject to subpart F of this part. This includes the accounting techniques and valuation methodologies used, including key assumptions and practices affecting valuation as well as significant changes in these practices. Value disclosed on the balance sheet of investments, as well as the fair value of those investments; for securities that are publicly traded, a comparison to publicly-quoted share values where the share price is materially different from fair value. Disclosure Page Securitizations Pg. 12-13 Securitizations Pg. 12-13 Not applicable. CSC does not securitize assets. Not applicable. CSC does not have any resecuritization exposures. Equity Securities Not Subject to the Market Risk Capital Rule Equity Securities Not Subject to the Market Risk Capital Rule Pg. 13 Pg. 13 Source Reference if applicable 8
Table Disclosure Requirement Disclosure Location Equities Not Subject to Subpart F of This Part (Table 9) - continued The types and nature of investments, including the amount that is: (1) Publicly traded; and (2) Non-publicly traded. The cumulative realized gains (losses) arising from sales (d) and liquidations in the reporting period. (1) Total unrealized gains (losses). (2) Total latent revaluation gains (losses). (e) (3) Any amounts of the above included in tier 1 or tier 2 capital. Capital requirements categorized by appropriate equity groupings, consistent with the Board-regulated institution s methodology, as well as the aggregate (f) amounts and the type of equity investments subject to any supervisory transition regarding regulatory capital requirements. Interest Rate Risk for Non-Trading Activities (Table 10) The general qualitative disclosure requirement, including the nature of interest rate risk for non-trading activities and key assumptions, including assumptions regarding loan prepayments and behavior of non-maturity deposits, and frequency of measurement of interest rate risk for non-trading activities. Equity Securities Not Subject to the Market Risk Capital Rule Not applicable. There were not any sales or liquidations in the reporting period. Not applicable. There are not any unrealized gains (losses) in the reporting period. Equity Securities Not Subject to the Market Risk Capital Rule MD&A Critical Accounting Estimates MD&A Risk Management Item 3 Quantitative and Qualitative Disclosures About Market Risk Disclosure Page Pg. 13 Pg. 13 Source Reference if applicable Pg. 50-51 Pg. 17-20 Pg. 26-27 Quantitative: The increase (decline) in earnings or economic value (or relevant measure used by management) for upward and downward rate shocks according to management s method for measuring interest rate risk for non-trading activities, categorized by currency (as appropriate). Item 3 Quantitative and Qualitative Disclosures About Market Risk Pg. 26-27 9
COMPONENTS OF CAPITAL A reconciliation of total stockholders equity to CET1 capital, additional Tier 1 capital, Tier 2 capital, and Total capital is as follows: (Dollars in Millions, Unaudited) September 30, 2016 Total stockholders equity $ 15,470 Less: Preferred Stock 2,192 CET1 capital before regulatory adjustments 13,278 Less: Goodwill, net of associated deferred tax liabilities 1,180 Other intangible assets, net of associated deferred tax liabilities 51 Deferred tax asset, net of valuation allowances and deferred tax liabilities 1 AOCI adjustment (1) 31 CET1 Capital 12,015 Additional Tier 1 Capital Preferred stock 2,192 Tier 1 capital 14,207 Allowance for loan losses 27 Tier 2 capital 27 Total capital $ 14,234 (1) CSC made a one-time election to opt-out of the requirement to include most components of AOCI in CET1 Capital. Refer to the Condensed Consolidated Balance Sheets on page 30 of the September 30, 2016 for the components of stockholders equity. CAPITAL ADEQUACY The Company seeks to manage capital to a level and composition sufficient to support execution of its business strategy, including anticipated balance sheet growth, providing financial support to its subsidiaries, and sustained access to the capital markets, while at the same time meeting its regulatory capital requirements and serving as a source of financial strength to Schwab Bank. The Company s primary sources of capital are funds generated by the operations of its subsidiaries and securities issuances by CSC in the capital markets. To ensure that it has a sufficient amount of capital to absorb unanticipated losses or declines in asset values, the Company has adopted a policy to remain well capitalized even in stressed scenarios. Internal guidelines are set, for both the Company and its regulated subsidiaries, to ensure capital levels are in line with the Company s strategy and regulatory requirements, and capital forecasts are reviewed monthly at Capital Planning and Asset-Liability Management and Pricing Committee meetings. A number of early warning indicators are monitored to help identify potential problems that could impact capital. In addition, the Company monitors its subsidiaries capital levels and requirements. Subject to regulatory capital requirements and any required approvals, any excess capital held by subsidiaries is transferred to CSC in the form of dividends and returns of capital. When subsidiaries have need of additional capital, funds are provided by CSC as equity investments and also as subordinated loans (in a form approved as regulatory capital by regulators) for Schwab. The details and method used for each cash infusion are based on an analysis of the particular entity s needs and financing alternatives. The amounts and structure of infusions must take into consideration maintenance of regulatory capital requirements, debt/equity ratios, and equity double leverage ratios. 10
STANDARDIZED RISK-WEIGHTED ASSETS (RWA) The Basel III standardized approach RWA is calculated based on the Rule. The following table provides CSC s distribution of RWA by exposure categories prescribed by the applicable regulations. For a distribution of CSC s RWA by balance sheet categories, see Schedule HC-R of the for the period ended September 30, 2016. The following details the Company s RWA under the standardized approach. (Dollars in Millions, Unaudited) September 30, 2016 RWA by applicable Basel exposure category: Exposures to sovereign entities $ 10,777 Exposures to depository institutions, foreign banks, and credit unions 2,125 Exposures to public sector entities 466 Corporate exposures 11,024 Residential mortgage exposures 7,098 Past due loans 27 Other assets 8,517 Securitization exposures 22,199 Equity exposures 352 RWA for balance sheet asset categories 62,585 Off-balance sheet items 4,209 Total RWA under standardized approach $ 66,794 CAPITAL RATIOS The following details the Company s capital ratios. September 30, 2016 Actual Minimum Required Well Capitalized (Dollars in Millions, Unaudited) Amount Ratio Amount Ratio Amount Ratio CSC Common Equity Tier 1 Risk-Based Capital $ 12,015 18.0% $ 3,006 4.5% N/A Tier 1 Risk-Based Capital 14,207 21.3% 4,008 6.0% N/A Total Risk-Based Capital 14,234 21.3% 5,343 8.0% N/A Schwab Bank Common Equity Tier 1 Risk-Based Capital $ 11,142 18.8% $ 2,660 4.5% $ 3,843 6.5% Tier 1 Risk-Based Capital 11,142 18.8% 3,547 6.0% 4,730 8.0% Total Risk-Based Capital 11,168 18.9% 4,730 8.0% 5,912 10.0% N/A Not applicable CAPITAL BUFFER Beginning on January 1, 2016, CSC and Schwab Bank became subject to a new capital conservation buffer requirement of.625% of risk-weighted assets, increasing each year by.625% until fully implemented at 2.5% of risk-weighted assets in January 2019. The capital conservation buffer is in addition to the minimum risk-based capital requirements described above. Failure to maintain the capital conservation buffer would limit an entity s ability to make capital distributions and discretionary bonus payments to executive officers. At September 30, 2016, CSC s and Schwab Bank s capital levels exceeded the fully implemented capital conservation buffer requirement. CREDIT RISK CSC s exposure to credit risk mainly results from margin lending and client option and futures activities, securities lending activities, mortgage lending activities, pledged asset lending, its role as a counterparty in financial contracts and other investing activities. To manage the risks of such losses, the Company has established policies and procedures which include: establishing and reviewing credit limits, monitoring of credit limits and quality of counterparties, and adjusting margin, Pledged Asset Lines (PALs), option, and futures requirements for certain securities. Collateral arrangements relating to 11
margin loans, PALs, option positions, securities lending agreements, and resale agreements include provisions that require additional collateral in the event market fluctuations result in declines in the value of collateral received. Additionally, for margin loan, PAL and securities lending agreements, collateral arrangements require the fair value of such collateral exceeds the amounts loaned. The Company s credit risk exposure related to loans is actively managed through individual loan and portfolio reviews. Management regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for loan losses. The Company s loan portfolios primarily include first lien residential real estate mortgage loans (First Mortgages) of $8.8 billion, home equity lines of credit (HELOCs) of $2.4 billion, PALs of $3.6 billion and customer account margin loans of $14.9 billion at September 30, 2016. The Company has exposure to credit risk associated with its available for sale and securities held to maturity securities, whose carrying values totaled $74.3 billion and $67.2 billion at September 30, 2016, respectively. These portfolios include U.S. agency and non-agency mortgage-backed securities (MBS), asset-backed securities (ABS), corporate debt securities, U.S. agency notes, U.S. Treasury securities, certificates of deposit, U.S. state and municipal securities, and commercial paper. U.S. agency MBS do not have explicit credit ratings; however, management considers these to be of the highest credit quality and rating given the guarantee of principal and interest by the U.S. government-sponsored enterprises. SECURITIZATIONS The disclosures in this section refer to securitizations held in the Company s investment portfolio and the regulatory capital related to these exposures calculated according to the Rule. Under the Rule, a securitization is a transaction in which credit risk of one or more underlying exposures has been transferred to one or more third parties, where the credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority, where performance of the securitization exposures depends on the performance of the underlying exposures and substantially all of the underlying exposures are financial exposures. Securitizations therefore exclude CSC s investment in pass-through securities issued by government agencies. A participant in the securitization market is typically an originator, investor, or sponsor. CSC s securitization-related activity is investing in products created by third parties. Securitization exposures held in the Company s investment portfolio include traditional agency and non-agency ABS and MBS securitizations. The Company does not have any synthetic securitization exposure and does not act as a sponsor; therefore, the following tables relate to the Company as an investor. The Company utilizes the gross-up approach to determine RWA for its securitization exposures. This approach considers the Company s seniority in the securitization structure and risk factors inherent in the underlying assets. 12
Securitizations by exposure type are shown below. (Dollars in Millions, Unaudited) Carrying Value September 30, 2016 Risk-weighted Asset Value Mortgage-backed securities: Agency Commercial $ 28,707 $ 5,730 Agency Residential 10,823 2,162 Non-agency Commercial 1,051 1,051 Asset-backed securities: Auto 945 945 Credit Card 7,237 7,213 Student loan 10,349 2,122 Dealer floorplan 2,976 2,976 Total securitizations $ 62,088 $ 22,199 Securitizations by capital requirement and risk-weight bands are summarized below. September 30, 2016 Risk-Weighted Asset Capital Impact of RWA (1) (Dollars in Millions, Unaudited) Carrying Value 20% $ 49,903 $ 10,014 $ 801 100% 12,185 12,185 975 Total Securitizations $ 62,088 $ 22,199 $ 1,776 (1) The capital impact of RWA is calculated by multiplying risk-weighted assets by the minimum total risk-based capital ratio of 8%. EQUITIES NOT SUBJECT TO THE MARKET RISK CAPITAL RULE The Company has total equity exposures of approximately $352 million at September 30, 2016. The majority are classified as trading assets totaling $228 million held for operational customer accommodation purposes and investments made relating to the Company s deferred compensation plan. These are recorded at fair value. Other individual investments are related to the Company s community reinvestment activities totaling $43 million and investment in FHLB stock totaling $81 million. The Company uses the Simple Risk-Weight Approach for its individual equity investments. Non-marketable equity securities are generally recorded either at historical cost or using the equity method. Details of the Company s accounting policy for equity investments and the valuation of financial instruments are provided in Note 2 - Summary of Significant Accounting Policies in the, Fair value of other financial instruments. SUBSEQUENT EVENT On October 31, 2016, the Company issued and sold 600,000 depositary shares, each representing a 1/100 th ownership interest in a share of fixed-to-floating rate non-cumulative perpetual preferred stock, Series E, $0.01 par value, with a liquidation preference of $100,000 per share (equivalent to $1,000 per depositary share) (Series E Preferred Stock). The Series E Preferred Stock has a fixed dividend rate of 4.625% through February 28, 2022, payable semi-annually, and thereafter at a floating rate of three-month LIBOR plus a fixed spread of 3.315%, payable quarterly. Net proceeds received from the sale were $591 million and are being used to support balance sheet growth, including the migration of certain client balances from sweep money market funds into Schwab Bank. 13